Expert Speak India Matters
Published on Sep 01, 2022 Updated 26 Days ago
Reducing the trade deficit is essential for economic growth. Better policymaking can aid to that end.
Leveraging exports for economic growth

After inflation levels in India cool down, hopefully in the first quarter of the next fiscal year (Reserve Bank of India (RBI) estimate), after the Ukraine crisis becomes dormant, the problem of low growth is likely to persist. The absence of sustainable, domestic demand growth beyond the surging incomes of the top two quintiles remains a worry.

So, why not export our way out of this downturn (2022-2025) by when real incomes could improve for the middle two quintiles, which would then sustain the next growth spurt from 2025 till 2030?

Admittedly, it is not the best time to be hanging our hat by the export hook. In the aftermath of the Ukraine crisis, the globe is uncomfortably split into three leaky silos. First, the Western alliance comprising the United States (US), its allies, and the European Union versus the new grouping of Russia and China with their respective allies, and finally, others who prefer to retain strategic autonomy. India falls in the third category as the country’s size, location, and political architecture make any other approach unviable.

The Western alliance comprising the United States (US), its allies, and the European Union versus the new grouping of Russia and China with their respective allies, and finally, others who prefer to retain strategic autonomy.

We are physically most proximate to China which rebuffs collegial coexistence in search of global dominance. We “manage China” at the cost of distancing ourselves from the advantages of participating in the Regional Comprehensive Economic Partnership—the trade pact governing the world’s fastest-growing region.

Exporting past the domestic demand slump

Contrary to popular conception, India does well on the export of goods and services—if natural resources export-based economies (whose exports can account for over 70 percent of gross domestic product (GDP)) are stripped out of the comparator set and the potentially large size of our domestic economy is factored in.

In 2021, India, with an export share in GDP of 20.8 percent, was 0.8 percentage points ahead of China at 20 percent. It is important to note, however, that the 2021 data could also reflect the severe COVID-19 supply constraints in China which may have depressed their exports. In 2008, when the share of exports to GDP in China peaked at 31.2 percent, India was 10 percentage points behind with a share of 26 percent.

India needs to step up closer to the world average share of exports in GDP of 29.1 percent. India peaked in 2013 at 25.4 percent; retracing our steps could be one way of recovering export share.

Stoking exports is a medium to long-term task—reducing logistical costs through better infrastructure and even more importantly, process reform to simplify tax and export control processes.

India has the image of a marginal exporter, and this must be refurbished. Stoking exports is a medium to long-term task—reducing logistical costs through better infrastructure and even more importantly, process reform to simplify tax and export control processes. Furthermore, a sustained branding effort in targeted export markets and active participation in trade and economic cooperation partnerships is also necessary.

Special Economic Zones

Unlike China, Indian exports are an offshoot of generalised industrial and service sector competitiveness, using the comparative advantage of low wages, skilled workforce, and supply chains developed in the domestic economy over decades.

Attempts to mimic China’s enclaved export promotion have been moderately successful. Starting in 1980 by 2007 China's Special Economic Zones (SEZs), industrial parks and zones (numbering over 5000) accounted for 60 percent of exports, 22 percent of GDP, and generated employment for 30 million. The Indian experience is longer (since 1965), but less productive. Successive policy initiatives, ending in supportive legislation in 2005, support 268 export-only operational enclaves which accounted for US $112.4 billion, or 21 percent of total goods and services exports of US $526.6 billion in 2019–20. Around 300 notified SEZs (some not yet operational) are located within 41,970 hectares. Most are industrial clusters rather than entire communities, cities, or regions, as in China.

Politics, parties, and partnerships

There are two significant differences between the Indian and the Chinese strategies. First, and linked to the intense political contestation in India, the Union government often invests in and manages such export facilities. In China, provinces and cities were encouraged to lead in constituting and managing such enclaves in collaboration with the private sector.

The Indian experience is longer (since 1965), but less productive. Successive policy initiatives, ending in supportive legislation in 2005, support 268 export-only operational enclaves which accounted for US $112.4 billion, or 21 percent of total goods and services exports of US $526.6 billion in 2019–20.

In India, the Central political leadership actively nurtures projects and programs closely identified with them to retain political influence and public credibility. This is quite like the present need of President Xi to carve out a special place for himself in China versus other leaders. This is one reason why decentralised implementation, within the overall management of the Communist Party of China, has limited salience in India.

Competing macro-economic objectives

Secondly, the framework for macroeconomic stability followed by India effectively treats exports as residual, as opposed to China where exports are the focal point. In India, greater prominence is given to political economy metrics like consumer protection from inflation, and protection for producers from cheaper imports.

The reappearance of an active industrialisation policy, AtmaNirbhar Bharat (self-reliant India), four decades after industrial liberalisation, inefficiently subsidises domestic producers by implicitly transferring to them the benefits that consumers would have enjoyed from cheap imports via the ability to charge higher prices in the absence of imported competition.

The justification is that domestic value addition is better than cheap imports because it creates jobs. Whilst this might be true in specific cases in the near term, the very same import constraints generate efficiency loss peculiar to a closed economy ecosystem, unused to imported innovation-based competition. The insistence of TESLA to test-import their cars at a reasonable tariff as a precondition for investment in India is one such example.

Exports, only residual in macroeconomic stability

A second drawback for exports is the absence of a level playing field because of the preference for a “strong Indian Rupee (INR)”. India remembers a substantial annual trade deficit of just below 7 percent of GDP from 2011 to 2013 resulting in a sharp depreciation of the INR. The trade deficit reduced to between 1 to 2 percent of GDP during 2014-17 as the price of imported oil decreased. It reverted to more than 3 percent of GDP in subsequent years till 2019-20 (the last normal, pre-pandemic year) as the price of oil firmed up.

The gap is met by capital inflows—either remittances, portfolios, or foreign direct investments. Monetary policy consequently strives to retain enough fat in domestic interest rates to preserve the incentive for inward capital flows to strengthen the INR. One reason Indian stocks remain expensive is that they expect the RBI not to allow the INR to depreciate. Since 2019, despite around 10 percent depreciation in the nominal exchange rate of the INR, the gap with the real exchange rate of the INR has widened because adequate inflation adjustments have not been made in the nominal exchange rate of the INR.

Monetary policy consequently strives to retain enough fat in domestic interest rates to preserve the incentive for inward capital flows to strengthen the INR.

This strategy helps avoid imported inflation (by partly neutralising the firm trend in global oil and gas prices even before the Ukraine crisis) but is damaging for exports which become uncompetitive. This fallback, defensive strategy minimises foreign exchange imbalances through subsidies for capital inflow. However, it also acts as a tax on exports which risks ballooning the trade deficit (the difference between exports and imports) instead.

Making exports competitive is an across-the-economy, medium-term objective which s the range of providing more subsidies for targeted research and development; targeted subsidies to industry and business for skill, technology, and process upgrades; punitive taxes for noncompliance with efficiency and quality standards; a friendly business development ecosystem; and better infrastructure as evidenced by lower logistical cost and stable macroeconomic conditions.

Charming investors away from their Chinese obsession

In recent times, the possibility of pulling foreign investment away from China and into India by transforming it into a global hub for exports is considered “low-hanging fruit.” This perception seems naïve, as the commercial compulsion to be present in China—the most competitive large economy with a well-developed playbook for garnering foreign investment, technology, and exports—is unlikely to disappear overnight. Even if it does, India barely qualifies for “friend-shoring” and not at all for “near-shoring.”

Despite existing political compulsions to flex muscle and downsize large businesses, the Chinese Communist Party remains equally bound to safeguard its legitimacy by delivering the benefits of high economic performance to citizens.

An inward-looking China risks imploding under the weight of its own external and domestic commitments. Despite existing political compulsions to flex muscle and downsize large businesses, the Chinese Communist Party remains equally bound to safeguard its legitimacy by delivering the benefits of high economic performance to citizens. By risking that, they risk the social contract on which China works.

Sooner, rather than later, China will be compelled to privilege economic efficiency over political grandstanding. Economic compulsions will revive the premium on the number of mice caught rather than the cat’s colour, to misquote Deng Xiaoping, the great strategist. No doubt when this happens, global businesses will resume profitable collaboration with China.

It is defeatist to rely on a competitor destroying itself for the sake of growth. Managing China should include de-hyphenating geopolitics and security from trade and investment. Better to be an Angela Merkel than a Volodymyr Zelensky.

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Author

Sanjeev Ahluwalia

Sanjeev Ahluwalia

Sanjeev S. Ahluwalia has core skills in institutional analysis, energy and economic regulation and public financial management backed by eight years of project management experience ...

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